by Murray Rothbard
(Contents by Publication Date)
The Cross of Fixed Exchange Rates
Governments, especially including the U.S. government, seem to be congenitally incapable of keeping their mitts off any part of the economy. Government, aided and abetted by its host of apologists among intellectuals and policy wonks, likes to regard itself as a deus ex machina (a "god out of the machine") that surveys its subjects with Olympian benevolence and omniscience, and then repeatedly descends to earth to fix up the numerous "market failures" that mere people, in their ignorance, persist in committing.
The fact that history is a black record of continual gross failure by this "god," and that economic theory explains why it must be so, makes no impression on official political discourse.
Every Nation-State, for example, is continually tempted to intervene to fix its exchange rates, the rates of its fiat paper money in terms of the scores of other moneys issued by all the other governments in the world.
Governments don't know, and don't want to know, that the only successful fixing of exchange rates occurred, not coincidentally, in the era of the gold standard. In that era, money was a market commodity, produced on the market rather than manufactured ad lib. by a government or a central bank. Fixed exchange rates worked because these national money units--the dollar, the pound, the lira, the mark, etc.--were not independent things or entities. Rather each was defined as a certain weight of gold.
Like all definitions such as the yard, the ton, etc., the point of the definition was that, once set, it was fixed forever. Thus, for example, if, as was roughly the case in the nineteenth century, "the dollar" was defined as 1/20 of a gold ounce, "the pound" as 1/4 of a gold ounce, and "the French franc" as 1/100 of a gold ounce, the "exchange rates" were simply proportional gold weights of the various currency units, so that the pound would automatically be worth $5, the franc would automatically be worth 20 cents, etc.
The United States dropped the gold standard in 1933, with the last international vestiges discarded in 1971. After the whole world followed, each national currency became a separate and independent entity, or good, from all the others. Therefore a "market" developed immediately among them, as a market will always develop among different tradable goods.
If these exchange markets are left alone by governments, then exchange rates will fluctuate freely. They will fluctuate in accordance with the supplies and demands for each currency in terms of the others, and the day-to-day rates will reflect supply and demand conditions and, as in the case of all other goods, "clear the market" so as to equate supply and demand, and therefore assure that there will be no shortages or unsold surpluses of any of the moneys.
Fluctuating fiat moneys, as the world has discovered once again, since 1971, are unsatisfactory. They cripple the advantages of international money and virtually return the world to barter. They fail to provide the check against inflation by governments and central banks once supplied by the stern necessity of redeeming their monetary issues in gold.
What the world has failed to grasp is that there is one thing much worse than fluctuating fiat moneys: and that is fiat money where governments try to fix the exchange rates. For, as in the case of any price control, governments will invariably fix their rates either above or below the free market rate. Whichever route they take, government fixing will create undesirable consequences, will cause unnecessary monetary crises, and, in the long run, cannot be sustained and will end up in ignominious failure.
One crucial point is that government fixing of exchange rates will inevitably set "Gresham's Law" to work: that is, the money artificially undervalued by the government (set at a price too low by the government) will tend to disappear from the market ("a shortage"), while money overvalued by government (price set too high) will tend to pour into circulation and constitute a "surplus."
The Clinton Administration, which seems to have a homing instinct for economic fallacy, has been as bumbling and inconsistent in monetary policy as in all other areas. Thus, until recently, the administration, absurdly worried about a seemingly grave (but actually non-existent) balance of payments "deficit," has tried to push down the exchange rate of the dollar in order to stimulate exports and restrict imports.
There is no way, however, that government can ever find and set some sort of "ideal" exchange rate. A cheaper dollar encourages exports all right, but the administration eventually came to realize that there is an inevitable down side: namely, that import prices of course are higher, which removes competition that will keep domestic prices down.
Instead of learning the lesson that there is no ideal exchange rate apart from determination by the free market, the Clinton Administration, as is its wont, reversed itself abruptly, and orchestrated a multi-billion campaign by the Fed and other major central banks to prop up the sinking dollar, as against the German mark and the Japanese yen. The dollar rate rose slightly, and the media congratulated Clinton for propping up the dollar.
Overlooked in the hosannahs are several intractable problems. First, billions of taxpayers money, here and abroad, are being devoted to distorting market exchange rates. Second, since the exchange rate is being coercively propped up, such "successes" cannot be repeated for long. How long before the Fed runs out of marks and yen with which to keep up the dollar? How long before Germany, Japan, and other countries tire of inflating their currencies in order to keep the dollar artificially high?
If the Clinton Administration persists, even in the face of these consequences, in trying to hold the dollar artificially high, it will have to meet the developing mark and yen "shortages" by imposing exchange controls and mark-and-yen-rationing on American citizens.
In the meantime, one of the first bitter fruits of Nafta has already appeared. Like all other modern "free trade" agreements, Nafta serves as a back-channel to international currency regulation and fixed exchange rates. One of the unheralded aspects of Nafta was joint government action in propping up each others' exchange rates. In practice, this means artificial overvaluation of the Mexican peso, which has been dropping sharply on the market, in response to Mexican inflation and political instability.
Thus, Nafta originally set up a "temporary" $6 billion credit pool to aid mutual overvaluation of exchange rates. With the peso slipping badly, falling 6% against the dollar since January, the Nafta governments, in late April, made the credit pool permanent, and raised it to $8.8 billion. Moreover, the three Nafta countries created a new North American Financial Group, consisting of the respective finance ministers and central bank chairman, to "oversee economic and financial issues affecting the North American partners."
Robert D. Hormats, vice-chairman of Goldman Sachs International, hailed the new arrangement as "a logical progression from trade and investment cooperation between the three countries to greater monetary and fiscal cooperation." Well, that's one way to look at it. Another way is to point out that this is one more step of the U.S. government toward arrangements that will distort exchange rates, create monetary crises and currency shortages, and waste taxpayers money and economic resources.
Worst of all, the U.S. is marching inexorably toward economic regulation and planning by regional, and even world, governmental bureaucracies, out of control and accountable to no one, to none of the subject peoples anywhere on the globe.